05/18/2022
A U.S. Based Corporation With A Foreign Subsidiary: What Factors Must Be Considered For Tax Purposes?
Some Corporations based in the U.S. want to expand their business to foreign countries. One of the most common ways to expand a business is to establish a foreign Subsidiary. There are some advantages to having a foreign Subsidiary for a Corporation based in the U.S. However, some additional forms and reports must be handled for compliance with U.S. tax laws. Below are the factors that must be considered by a U.S.-based Corporation with a foreign Subsidiary.
1. The first thing that must be done by a U.S.-based Corporation after establishing a foreign Subsidiary is selecting how to treat a Subsidiary for U.S. tax purposes (“check-the-box” élection). There are two possible options below:
a.Treat Subsidiary as a stand-alone foreign Corporation: The Subsidiary will file tax returns under the rules of its country. However, the Parent will need to file “Information Return of U.S. Persons concerning Certain Foreign Corporations” (form 5471), with its U.S. tax return. This form is used to report the income and expenses of the foreign Subsidiary with no effect on the income or loss of the Parent.
b. Treat Subsidiary as a disregarded entity: The Parent will need to include the income and expenses of the Subsidiary on its U.S. income tax return. For this reason, the “Information Return of U.S. Persons concerning Foreign Disregarded Entities” (form 8858) must be attached to the return.
This form reports information similar to that in Form 5471 but a concise manner. However, this option would most likely not be recognized in the Subsidiary’s country of formation and the Subsidiary would still need to file a foreign income tax return.
Which option should be selected by a Corporation with a foreign Subsidiary? This depends on many factors. One of the most important factors is considering if you expect profit or loss from a foreign Subsidiary, especially for the first years of its activity. If you expect profit for a foreign Subsidiary, then it may be best to choose the, “Treat subsidiary as a stand-alone foreign corporation” option. However, if you expect a loss for a foreign Subsidiary, then it may be most effective to choose the “Treat subsidiary as a disregarded entity” option. It is vital to select the appropriate and most effective option for your foreign Subsidiary for tax purposes because once the selection is made it cannot be changed for 5 years.
2. Additional reports or forms must also be handled by a Corporation with a foreign Subsidiary. Below are the main forms that may be required as well.
a. The first possible required form is “Return by a U.S. Transferor of Property to a Foreign Corporation” (form 926). Generally, this form is required to be completed if a U.S.-based Corporation transfers cash or property to a foreign corporation. Regarding transfers of cash, it must be reported immediately after the transfer if the U.S.-based Corporation holds at least 10% of the total value of the foreign Corporation’s stock or if the total cash transferred during the year exceeds $100,000.
b. The second possible required form is “Report of Foreign Bank and Financial Accounts” (form 114). This is required for all U.S. taxpayers who have a financial interest and/or signature authority over accounts in foreign countries that exceed $10,000. The Parent has a financial interest in any foreign account that the Subsidiary maintains in its country of operation since it has 100% ownership of the Subsidiary. This form reports the highest balance of each bank account during the tax year.
c. While some of the reporting requirements include forms that need to be filed either with the Parent’s U.S. tax return or separately, some requirements include the preparation of schedules within the Parent’s tax return. One of these schedules is “Foreign Operations of U.S. Corporations” (Schedule N). This form must be completed by a Corporation that had assets or operated a business in a foreign country at any time during the tax year. The form generally contains yes or no questions that aid the taxpayer in determining which forms to include with its return. In our example, the parent would need to complete this form with its U.S. tax return.
In addition to the above-mentioned forms and reports, some other factors must be considered by a Corporation with a foreign Subsidiary. One of these factors is called the “Third Transfer Pricing: The Case for an Arm’s Length” (the pricing of intercompany transactions between Parent and Subsidiary will need to be determined). This means that the price a company pays to purchase goods or services from a related company should be the same as if the two entities were unrelated. In other words, there should be no price adjustments or special conditions for the transaction simply because the parties are related legal entities.
